What is the 'Network Effect'

The network effect is a phenomenon wherein increased numbers of people or participants improve the value of a good or service. The internet is such an example. Initially, there were few users of the internet. It was of relatively little value to anyone outside of the military and a few research scientists. As more users gained access to the internet, they produced more content, information and services. More and more websites were also developed and more users connected to communicate with each other. These developments made the internet increasingly valuable to its users.

BREAKING DOWN 'Network Effect'

The rise of social media can be directly correlated to the network effect. The more users present on Twitter sharing comments, links and media, the more useful the platform became to the public. Similar growth through the network effect was seen with Facebook, YouTube and Instagram. The escalation of users on those platforms fostered more interest from even more users. Corporations have also sought to participate with these platforms to engage in the expanding conversations among the many consumers who interact online.

What the Network Effect Means to Businesses

A variety of services-for-hire apps and websites also benefit from the network effect. As more professionals list online they are available as dog walkers, tutors, or even electricians, even more customers begin to rely on such directories. E-commerce sites such as Etsy and eBay grew in popularity as more sellers joined those marketplaces and sold their products to the influx of consumers who embraced shopping online.

Ridesharing services also evolved and grew through the support of more participants signing up and expanding their reach across cities and states. As more drivers became part of Uber and Lyft, those brands gained in market value with passengers seeking rides.

The chief hurdle for any good or service that uses the network effect is to get enough users initially so that the network effects take hold. The amount of users required for significant network effects is often referred to as critical mass. After critical mass is attained, the good or service should be able to attract many new users because its network offers utility.

If too many people use a good or service, negative network effects such as congestion can occur. In the internet example, having too many users on the same network service can hypothetically cause the speed to deteriorate, decreasing utility for users. Providers of goods and services that use a network effect must ensure that capacity can be increased sufficiently to accommodate all users.

RELATED TERMS
  1. Social Networking

    Social networking is the use of internet-based social media programs ...
  2. Economic Network

    An economic network is a combination of individuals, groups or ...
  3. Value Network Analysis

    Value network analysis is the assessment of the members and resources ...
  4. Distribution Network

    A distribution network is a company's interconnected group of ...
  5. Monthly Active User (MAU)

    Monthly Active User (MAU) is a key performance indicator (KPI) ...
  6. Revenue Per User - RPU

    Revenue per user is a ratio used to express revenue generated ...
Related Articles
  1. Small Business

    What Facebook Owns That Other Social Media Do Not (FB)

    Examine Facebook's competitive advantage to understand how the network effect and application suite set it apart from other social media platforms.
  2. Investing

    Social Media Will Soon Hit 2.5B Users: eMarketer

    Social media usage is forecast to jump more than 8% this year to 2.46 billion users worldwide.
  3. Investing

    Twitter: A Company in Search of a Turnaround Story (TWTR)

    Will Twitter's most recent earnings report bring good news to the company's investors?
  4. Investing

    Druckenmiller-backed "LinkedIn for the 1%" Opens to the Public

    The network, called Relationship Science, aims to provide links between high profile individuals in the worlds of business, finance, and law.
  5. Small Business

    How Facebook Beat MySpace

    Facebook became the leader of social media by offering users a clean design and the right mix of customization options.
  6. Small Business

    What Is Facebook’s Advantage Over Other Social Media? (FB)

    Discover the elements that define Facebook, which boasts 1.6 billion users who cement the company as the world's top social media outlet.
  7. Investing

    Facebook Set to Monetize 1.2 Billion Users on Messenger App

    Ads are coming to Facebook Messenger, promising to boost the social media network’s revenues and potentially irk users.
  8. Investing

    Facebook Bug Affected 800,000 Users

    A Facebook bug, now fixed, allowed blocked users to start conversations and access certain features.
  9. Investing

    Facebook, Twitter See User Growth in March Quarter

    Done reporting Q1 earnings, the pair enjoyed a blowout quarter while Snap struggles.
  10. Investing

    Analyzing Porter's 5 Forces on Facebook (FB)

    Read about how you can use Porter's five forces to analyze Facebook's competition. This simple methodology looks at several different factors or forces.
RELATED FAQS
  1. What's the difference between the income effect and the price effect?

    Learn what the price effect is and how it is related to consumer spending. Learn what two components make up the price effect ... Read Answer >>
  2. How does Facebook make money?

    Facebook has gone from losses to a money spinner in a short span of time. Where do its profits come from? Read Answer >>
  3. What are the advantages of paying with Bitcoin?

    Learn how payments made with Bitcoins offer certain advantages over standard currency, including user anonymity, no taxation ... Read Answer >>
  4. How Does Uber Make Money?

    Have you ever used Uber and wonder how did they set the price? Here is an inside look at how ridesharing companies like Uber ... Read Answer >>
  5. What is the effective interest method of amortization?

    Find out more about the rationale and advantages of the effective interest rate method and how it is used to amortize a discounted ... Read Answer >>
Trading Center